Banking regulator defends mortgage stress test, open to change when warranted

TORONTO — Canada's financial regulator hit back at criticisms of its stress test for uninsured mortgages, which has made it harder for borrowers to qualify and weighed on national home sales, but said it is open to changes when warranted.

Although interest rates have gone up over the past year since it introduced the tighter mortgage underwriting regulations — which require a borrower to prove they can keep up with their payments if interest rates rise — a "margin of safety" is still "prudent", said Carolyn Rogers, the number two at the Office of the Superintendent of Financial Institutions on Tuesday.

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Interest rates remain historically low while personal debt levels remain high, and borrowers face other risks to their ability to pay their mortgage such as changes to their income or other expenses, said the assistant superintendent of regulation.

“Should that margin of safety be monitored, and should it be changed and adjusted if conditions in the environment change? Of course it should. OSFI monitors the environment on a continual basis… This analysis has, and will continue to inform our guideline development process," Rogers said to the Economic Club of Canada in Toronto.

The banking regulator also understands the need to "monitor the effects of the stress test under different interest rate changes," she said after her speech.

OSFI on Jan. 1, 2018 introduced tighter mortgage underwriting guidelines, the most significant of which was a stress test for homebuyers with a more than 20 per cent down payment.

These borrowers must prove that they can service their uninsured mortgage at a qualifying rate of the greater of the contractual mortgage rate plus two percentage points or the five-year benchmark rate published by the Bank of Canada. The policy reduces the maximum amount buyers will be able to borrow to buy a home. An existing stress test already required those with insured mortgages to qualify at the Bank of Canada benchmark five-year mortgage rule.

The Canadian Real Estate Association has said that the stress test has weighed on sales to varying degrees in all Canadian housing markets and will continue to do so this year.

Meanwhile, Canada's central bank has raised the benchmark rate five times since mid-2017, encouraged by a stronger economy, and signalled that more rate increases are likely.

National home sales fell by 2.5 per cent in December from the previous month to cap off the weakest annual sales since 2012.

Mortgage Professionals Canada said in a recent report that housing markets across the country were due to slow amid rising interest rates but "the reductions in activity that have occurred have been much larger than should have been expected, due to the mortgage stress tests, on top of prior policy changes that have constrained homebuying."

Rogers in her lunchtime speech addressed a raft of criticism of OSFI's stress test, including concerns about "unintended consequences" such as first-time homebuyers being locked out or having to defer their purchases.

“The escalating cost of homeownership in Canada, and its knock-on effects to the economy and to our society, is a problem... But the answer to that problem, cannot be more debt. And particularly, it cannot be more consumer debt, fuelled by lax underwriting standards," she said.

The assistant superintendent also responded to criticisms that the stress test for federally regulated lenders has reduced competition, as borrowers can avoid it if they renew their mortgage with their existing bank. Canada's largest banks have said they have seen an uptick in mortgage renewal rates in recent quarters.

OSFI has put in place a tracking system to monitor and guard against the risk of reduced competition, Rogers said.

"To date we haven't seen any evidence that banks are taking advantage of this to the detriment of borrowers… We will continue to monitor this and will continue to report our observations publicly and if we see the need to take action, we will," she said.

As well, worries that the stress test has led to borrowers who no longer qualify to turn to unregulated lenders, potentially leading some to make bad decisions at much higher interest rates or be taken advantage of by unscrupulous lenders is a "legitimate concern," Rogers said.

However, she noted, it "cannot be a reason not to act." Mortgage brokers and the real estate industry are in a good position to help manage this risk, she added.

"If you see risks, if you think these options are putting your purchaser or borrower in a vulnerable position, you should steer them away. It’s the right thing to do."

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